22 Jan 2024
We have a mystery at hand. India’s engagement with the world in terms of share in global trade has been rising. And yet, FDI into the economy has halved over the last year. It is easy to point finger at a much smaller global FDI pot, led by higher rates and tighter liquidity. But within that, India’s share has fallen. The weak FDI data is also at odds with investment intentions. Both UNCTAD’s and CMIE’s foreign investment intentionsdata, which are well correlated with each other, are rising. But unlike the past, higher intentions are not culminating into actual inflows. This, indeed, thickens the plot.
To understand what’s going on, we split FDI inflows into two distinct parts – physical and digital. After a rise in the pandemic period, both have been falling. Digital FDI is easier to explain. After a staggering increase in the pandemic period, global flowsinto tech start-ups fell, and India simply followed the global trend. With more conservative valuations now, the prospects could be brighter in 2024. The bigger mystery is the fall in physical FDI, despite a sharp rise in investment intentions. Some investigation offers fresh insights:
Shifting frontiers. We break down investment intentions across sectors. While inflows into the pandemic-period sectors such as computers and chemicals have slowed, investment intentions in futuristic sectors like renewables, data centres, EVs, green hydrogen, AI and semiconductors, are rising sharply. We outline examples of projects in some of these sectors, and note the rise in players like sovereign wealth funds, the Middle East, and the US. Being new, these sectors may take more time to settle, but as they do, a new wave of FDI could come in, taking gross FDI inflows back to pandemic-time peak-levels of USD55bn/year in a couple of years, and over time, even higher.
Less concentrated than before. We create a diffusion index which picks up the proportion of sectors where FDI intentions are rising. We find that FDI into India tends to be rather concentrated, i.e. periods of rising FDI in the past have been led by a fewer number of sectors. And rather counter-intuitively, in periods when investment intentions rose across more sectors, overall FDI weakened. This could mean that India has well-oiled machinery to attract inflows in select sectors, but not across the board. At a time when investment intentions are shifting from ‘a few’ pandemic-time to ‘several’ futuristic sectors, it is imperative that the ease of doing business improves across the board, to make a new wave of FDI inflows, a reality.
We have a mystery at hand. India’s engagement with the world in terms of market share in global trade has been rising. And yet, FDI into the economy has fallen recently. Generally, the two go hand-in-hand.
Furthermore, as India is rising in prominence on the world stage, and foreign investment intentions are rising impressively, actual FDI inflows have softened.
What’s going on, and where will it land? We probe this matter carefully, and find some not-so-obvious trends and takeaways.
Net FDI into India rose appreciably in the five years before the pandemic (from USD22bn in FY14 to USD31bn in FY19). During the pandemic it soared further (to USD44bn in FY21). Thereafter it has more than halved to USD13bn in the last 4 quarters (see chart 1). Which parts of FDI flows have led to this?
We look at:
Net FDI: FDI to India – FDI by India, and
FDI to India: Gross FDI – repatriation
We find that FDI to India has fallen while FDI by India remains unchanged (see chart 2). And within FDI to India, both, gross FDI has fallen, and repatriation has risen (see chart 3).
Looking across sectors, both industry and services FDI have weakened (see chart 4). In fact, for both these sectors, the FDI-to-GDP ratio has dipped below pre-pandemic levels (see chart 5)
There have been notable changes across sectors over time. Those in prominence a decade ago, like metals, conventional power, tourism and construction, are no longer the leading ones. Some smaller sectors from a decade ago, like computers, renewables and pharma, have gotten bigger (see chart 6).
Looking across the last five years, we find that flows into automobiles, computers, construction, and services, have fallen below 2019 levels (see chart 7). But to be fair, FDI rose very sharply for automobiles, computer and construction in 2021 (i.e. the pandemic period), and the fall in 2023 (the post pandemic period), could well be a period of payback.
It is easy to imagine that the global FDI pot has shrunk, leading to a fall in FDI flows across the world. After all, higher rates and tighter liquidity around the world would take their toll on all kinds of investments.
Indeed, we find that global FDI flows have slowed. But within that, India’s share has fallen, meaning that India is hurting more than some other countries. This is particularly visible when we look at FDI flows in the Asia or EM basket, excluding China (see charts 8 and 9).
This seems to be at odds with the fact that India is gaining market share in global trade, and in both goods and services exports (see chart 10). As we have discussed in previous reports, India has been gaining global market share in the exports of high-tech goods such as electronics, drugs and pharmaceuticals and automobile parts, as well as high-tech services.
The latter, in particular, is changing in size and form, as India has evolved from simply selling software solutions, to all kinds of professional services. Around 1,600 multinational companies (MNCs) have set up their captive global capability centres in India, producing services worth USD34bn (c1% of GDP) per year, and this pie is growing rapidly.
The weak FDI data is also at odds with investment intentions. On intentions, we have two data sources at hand. One is the UNCTAD’s announced greenfield FDI projects data and the other is CMIE’s announced foreign private sector projects. Both these data sources seem to be strongly correlated, i.e. they move in the same direction (see chart 11).
But the CMIE intentions are always higher than UNCTAD intentions, and there are a few good reasons for this. One, the UNCTAD data only refers to greenfield investments, while the CMIE database is broader. Two, UNCTAD records data when there is a clear indication that jobs and new capex will be created, while CMIE includes projects even before important licenses or land has been obtained/acquired, or the funding has been tied up[@shifting-frontiers].
We find that investment intentions have been a good predictor of FDI inflows in the past (see chart 12). But recently, the two have diverged. Intentions are rising, but not culminating into actual inflows.
This, indeed, thickens the plot further.
To understand what’s going on, we split FDI inflows into two distinct parts – physical and digital. Physical includes automobiles, pharmaceuticals and construction as some of the main sectors, while digital includes parts of computers, information & broadcasting, financial, telecommunication and consulting services as some of the main sectors. In recent years the share of digital and physical FDI has been broadly similar. A decade ago, physical FDI was about three times the value of digital FDI.
We find that after a rise in the pandemic period, both digital and physical FDI have been falling (see chart 13).
The fall in digital FDI is easier to explain. We believe this has much to do with tech start-ups. After a period of staggering increase in the pandemic period, global flows into tech start-ups have fallen (see chart 14), and India has just followed this global trend (see chart 15).
We believe that this clean-up and consolidation in this sector bode well for medium-term growth. In fact, IPOs in India have picked up in recent quarters, and it is likely that many start-up investors have got their ‘exit’ after a wait (see chart 16). This, along with more reasonable valuations now, could mean a somewhat better 2024 for the start-up ecosystem.
And the fall in FDI into tech start-ups can coexist with rising services exports. As explained above, we find that the rise in India’s services exports has been led primarily by professional services (rising by an average 25% y-o-y versus IT services exports rising 16% over the last 4 years), with a rising number of GCCs playing an important role. This increase in services exports does not have to be too FDI-intensive, for instance, if the real estate in question is rented rather than bought.
The bigger mystery is the fall in physical FDI. And we find that despite a sharp rise in physical investment intentions, physical FDI has been weak (see chart 17).
We take a closer look and find some new insights.
1.Shifting frontiers:
We break down physical investment intentions across sectors and find that a big change is underway. While pandemic period flows into sectors such as computers and chemicals have softened, investment intentions in new and futuristic sectors are rising quickly.
We find a meaningful spurt in investment intentions in renewables, AI, data centres, EV and battery, green hydrogen and semiconductors (see charts 18 and 19). In fact, India was a leading destination for AI-related FDI in 2022 (see chart 20).
In table 1, we outline examples of projects in some of these futuristic sectors (see table 1). We believe it is worth noting the rise in sovereign wealth funds, the Middle East, and the US, in investment intentions (see chart 21).
Being new, these sectors may take more time than normal to materialise. And when they do, a new wave of FDI will likely come in.
2.Less concentrated than before:
We create a diffusion index which picks up the proportion of sectors where FDI intentions are rising (i.e. change in investment intentions are rising as a share of GDP).
We find that FDI into India tends to be rather concentrated, i.e. in periods it has risen the most, it has also been led by a fewer number of sectors (see chart 22). And rather counterintuitively, in periods when investment intentions rise across many sectors (i.e. the diffusion index rises), overall FDI actually weakens.
This could mean that India has well-oiled machinery to attract inflows in select sectors, but not across the board. At a time when investment intentions are rising in several sectors, it is imperative that many more sectors are made easier to do business in. And in particular, the futuristic sectors, which are attracting most investment interest, must evolve in a manner that is conducive to FDI flowing into them.
We look at the correlation between FDI inflows and foreign investment intentions, when it was still strong, until a few years ago (between FY12 and FY18). As explained before, intentions were a good leading indicator of actual inflows into the economy during that time.
We assume that once the new sectors settle and become ready to absorb the FDI inflows, the same correlation will be applicable again.
This analysis suggests that going by the current trends in investment intentions, gross FDI inflows into India could rise back to the recent peak of USD55bn/year once the new sectors settle down. For instance, if it takes two more years, then by FY26, FDI inflows could be back to the pandemic-timepeak-levels of USD55bn/year, after posting USD42bn in FY23, and a forecasted USD27bn in FY24 (see chart 23).
To conclude, the sectors in favour are shifting from pandemic-time sectors to futuristic sectors. Overall investment intentions are buoyant. If the ease of doing business is supportive across sectors, a new wave of FDI will likely come back into the economy, taking FDI inflows back to peak levels over time, and potentially even higher.
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